The Government and the power companies are playing politics with the tariff, tilting it to tax larger residential consumers in order to subsidize the tariff for smaller ones. We call for a single flat-rate residential tariff and for it to be brought into line with the commercial tariff. Why should people be penalised for living together rather than on separate meters, or for spending more time at home, and why should they pay more than commercial users for the same amount of electricity?

Hong Kong's electricity tax4 January 2012

In all the noise surrounding the recent announcement of the 2012 tariffs by
HK's two electricity monopolies, there is a socialist signal. In order to
achieve lower (or even zero) rates of increase for low residential consumers,
the power companies, under political pressure, have jacked up the rates they charge to
higher residential consumers by a much larger percentage. This "tariff tilting",
which has been going on for some years,
amounts to a tax on larger residential consumers to subsidize the cost of
electricity for smaller residential consumers and businesses. It's socialism
with Hong Kong characteristics. Unlike almost
anything else you can buy, the more electricity you buy, the more expensive it
gets.

Under the Scheme
of Control Agreement with the Government, each of the power companies is allowed to make a capped rate of return (9.99%
after tax) on its average net fixed
assets. Put simply, if anyone pays more than the average tariff, then someone
else is paying less than the average in order to reach the same revenue for a
given amount of electricity which then produces the target profit.

CLP

Here's the
comparison of CLP's old and
new tariff (all-in, including the so-called fuel
clause charge):

Band ofunits bimonthly

Band ofunits monthly

2011$/unit

2012$/unit

Bandincrease

0-400

0-200

0.923

0.923

0.0%

401-1000

201-500

0.989

1.038

5.0%

1001-1800

501-900

1.049

1.179

12.4%

1801-2600 (new)

901-1300

1.049

1.355

20.1%

2601+

1301+

1.128

1.440

27.7%

As the table shows, consumers of more than 1300 units per month are now
paying 27.7% more than last year for each additional unit. The units above 1,300
cost 56.0% more than the cheapest units, compared with only a 22.2% premium last
year. This is what we mean by "tilting the tariff". Note that the above table includes the benefit of the 3.3 cents "Rent and
Rates Special Rebate" which will be of limited duration and is subject to
resolution of the court case, as we explain in our
separate article. Without that rebate, you can add 3.5% to the increase in each band. Also
note that CLP charges bimonthly, so we have halved the bimonthly bands to show the
average monthly bands.

CLP has abandoned plans to flatten out its commercial or "General Service" tariff, which
offers a slight discount to larger users, "until a wider public acceptance is
reached". The all-in price (net of the rebate) will be
$1.079 per unit on the first 5,000 units and $1.070 after that. That's a 5.0%
increase in both cases. We note that on the other side of the fragrant harbour,
HKE already charges commercial users a higher price for units consumed above 1,500 units/month,
not a discount. So apparently this "public acceptance" depends on where your business is
based. Overall, across all users (including bulk users - see below), CLP's average
tariff for 2012 (net of rebate) is $0.987/unit, up 4.9% from 2011. So users on the General
Service tariff are also paying more than the average tariff.

In 2012, the CLP residential tariff breaks even with the all-user tariff at
451 units per month (902 bimonthly), when the bill is $445.14. It breaks even with the
General Service tariff at 913 units per month, when the bill is $985.22. If you consume more than that in any month, you will
be paying more than a shop, office or hotel per unit, while subsidising those
residential users
who pay less. Incremental consumption above 1300 units
per month costs
you 33.5% more than the commercial tariff and a
whopping 45.9% more than the all-user tariff. The expansion of the electricity
tax is visible in the slope of the green curve below:

HKE

The Hongkong Electric Co., Ltd (HKE) already had a steep
residential price curve before this year, so there was less potential to tilt it
further, but they still steepened it a bit, and like CLP, they inserted a new
upper tariff band. The
residential tariff changed as follows:

Band of units monthly

2011$/unit

2012$/unit

Bandincrease

0-150

0.909

0.933

2.6%

151-300

1.012

1.048

3.6%

301-500

1.112

1.163

4.6%

501-700

1.353

1.428

5.5%

701-1000

1.448

1.543

6.6%

1000-1500 (new)

1.546

1.658

7.2%

1501+

1.546

1.683

8.9%

So residential users of more than 1,500 units now pay 8.9% more for the
additional units than last year. The additional units cost a whopping 80.4% more than the
cheapest units, compared with a 70.1% premium in 2011, making HKE's electricity
tax even higher than CLP's.

HKE's average all-user tariff rose by 6.3% from $1.233 to $1.311, while the
commercial tariff now has 3 bands: $1.316 for the first 1,500 units, a new
band of $1.421 for the next 18,500 units, and $1.446 above that. These represent
band increases of 6.0%, 6.4% and 8.2% respectively. The residential tariff breaks even with the all-user tariff at 1,094
units, when the bill is $1,434.10. It breaks even with the Commercial
Tariff at 1,110 units, when the bill is $1,460.63. Here are the 2011 and
2012 price curves:

Bulk discounts

Both companies offer discounts to large users who are willing to pay a
capacity charge based on their maximum power demand (in kilovolt-amperes). CLP
has a "Bulk Tariff" and
is available to customers whose present or expected consumption is over 20,000
units per month. For even larger customers (railways and steel smelters spring to
mind) there is a "Large Power Tariff". Presumably these tariffs work out
materially cheaper for customers who choose them. HKE's tariff, or what it calls the
Maximum Demand Tariff, offers savings for customers with at least 100 kVA of
maximum power demand.

There is of course some sense in the lower tariffs for large users - if you
have a factory, or run a train system like the MTR, then the power company has
economies of scale because it can deliver electricity to your gate and then you
handle your internal distribution, and only one bill is collected. But by the same argument, larger residential
users should actually be getting a slight discount rather than paying extra, because
the costs of metering, billing and collecting payment on such households is
spread over more units of energy. The same logic lies behind CLP's commercial
tariff. You will also find it in the
residential
tariff of The Hong Kong and China Gas Co Ltd (0003, also known as Towngas), where
the price declines as the user's consumption increases. Towngas is not subject
to any scheme of control, and gas is arguably less essential than electricity -
you can cook and heat your water with electricity, but you can't run your lights
or a TV with gas.

The steepening electricity tariff will make Towngas more attractive for
cooking, water heating and clothes drying. Currently, the first 500 megajoules
of Towngas energy are
charged at 21.9 cents plus a fuel cost adjustment of 5.8 cents per MJ. One unit
of electricity, a kilowatt-hour, is 3.6 MJ (a Joule is one Watt for one second),
so the gas equivalent costs $0.9972. That makes gas energy cheaper after you
have consumed your first 150 units of electricity in HKE's territory or 200
units in CLP's, although in the case of water heating, the energy efficiency of
gas versus electric heaters also comes into play, as energy is lost in hot exhaust
gases, so less is converted into hot water - an energy factor of around 0.7
compared with 0.9 for electric, so multiply that cost by about 1.3. Still, with
HKE charging up to $1.683 per unit and CLP at $1.440, it may now be cheaper to burn
gas than to pay the electricity companies to do it for you.

The socialist tariff

Regardless of the scheme of control, we see no reason why larger households
(with more people and consumption) should be charged at higher rates than small
ones, or why larger households should cross-subsidise commercial users which pay a lower tariff
for the same amount of consumption. If this is about incentivising energy
conservation, it is wrong to assume that households with higher consumption are
less energy efficient - they may simply have more people in them, or they may
spend more time at home (particularly if they are retired, looking after
children, working from home or telecommuting). Why penalise
them for living together rather than in separate homes on separate electricity
meters? Why penalise them for spending more time at home than other people? The main incentive to save energy is
already there in the basic cost of electricity.

This de facto electricity tax, which has
become steeper in the new tariffs, is devised purely for political rather than
economic reasons, in order to be able to show lower rates of increase (zero in
CLP's case) for
smaller consumers who tend to be correlated with smaller homes and lower
incomes. By leaning on the electricity companies to do this, the Government is
privatising social obligations. We call on the Government and the power
companies to flatten the tariff for residential users to a single price per unit
and bring it into line with the commercial tariff.

Apart from the steeply ramped residential tariff, the power
companies also provide
discounts for certain types of welfare recipients who are on
Comprehensive Social Security Assistance (CSSA). HKE
offers a 60% discount on the first 200 units for the elderly (over 60), the
disabled, single-parent families and the unemployed, while CLP
provides a
50%
discount on the first 200 units to elderly (over 60) CSSA
recipients. All of these come at the expense of higher tariffs for other users
so that the power companies can achieve their permitted return. It would be far
better for the Government to increase CSSA payments so that recipients can
afford electricity and require the power companies to charge all residential
users the same flat tariff.

In a Legislative Council
answer on 21-Dec-2011, the Government said that "this [tariff-tilting] arrangement will help
promote energy conservation" - but in fact, what it does is to make electricity
cheaper in real terms for the majority of households which are small, so if
anything, it has the opposite effect. It is unlikely that reduced consumption by the
minority in large households is enough to offset this.

Furthermore, not all small households are poor - some are bachelor bankers living in
pricey little flats in mid-levels, or people with a pied-�-terre or a rural
weekend home. So dishing out a subsidy in this way, taxing large consumers to
subsidize small ones, is a
scattergun approach to welfare, much of which misses its target. If people need
help paying their electricity bills, that is what the social welfare system
(including CSSA payments) is for. The Government should not shirk its
responsibilities by trying to privatize social obligations, nor should it play
politics with the tariff.

HKE v CLP

You may have noticed that HKE's 2012 average all-user tariff is 32.8% more than CLP's. Part of this
may be due to the difference in energy sources: CLP has nuclear power from Daya
Bay, while HKE does not. It may also be due to differences in the amount of
fixed asset investment per unit of energy produced, such as the amount they
spend on shiny headquarters and substations. Under the Scheme of
Control agreed with the Government, the power companies
are allowed to make a 9.99% rate of return on net fixed assets, known as the
"permitted return", after tax but before interest on borrowed capital. The
permitted return for CLP in 2010 was $8.568bn, or about 28.5% of revenue of
$30.016bn, while the permitted return for HKE was $4.752bn, or 36.0% of revenue
of $13.194bn. Nice work if you can get it.

Note that we said after tax: to make such a
profit before tax (at a tax rate of 16.5%) you would need to make not 9.99% but
11.96% return on fixed assets.

We don't like the SoC - the fixed rate of return on investment bears no
relation to the variable long-term cost of capital reflected by the corporate
bond and equity markets, and by linking profits to fixed assets, the SoC
incentivises companies to overinvest. It is undoubtedly true that overinvestment
produces higher reliability of supply up to a point, but it does so with
diminishing returns as we squeeze the last decimal points out of reliability.
According to CLP's annual report, its average unplanned Customer Minutes Lost
(CML) per year was 2.6 minutes in 2008-10, compared with 14 to 42 minutes in New
York, Sydney and London. How much are you willing to pay for the difference? And
how many planned minutes (or hours) of downtime for
preventative maintenance is needed to achieve this reliability?

That said, the Government
agreed to the current Scheme of Control, and shareholders of CLP and HKE
(probably including your MPF fund if you have one) expect the companies to
maximise their profits within the SoC. Indeed, it would be a breach of fiduciary
duties for the directors to deliberately lower the tariff to make less than the
allowed profit, unless they believed that this would be a net benefit to
shareholders in the long run. We should note that the Government itself
owns
2-3% of CLP Holdings Ltd (0002) and of
Power Assets Holdings Ltd (0006, the owner
of HKE) through the quasi-sovereign wealth fund known as the Exchange Fund (as well as smaller holdings via other
Government funds), so it has a conflict of interests in this matter, and has
done since it intervened in the stock market in 1998.

The cream

We couldn't conclude this article without mentioning that apart from the Scheme of Control profits, the power companies and their
owners have also made
large profits on the redevelopment of vacated sites over the years as HK's
urban landscape has expanded into what used to be industrial areas. For each
project, a land premium to Government to convert the land lease into residential
use or expand its plot ratio, but that still left room for ample profit. Smaller
sites of disused substations have also been developed.

HKE's old North Point power station became
City Gardens after it was closed in 1978, and the power station intended to
replace it on Ap Lei Chau,
opened in 1968, stood
for only about 20 years. In 1978, HKE was granted a new site on Lamma Island
which came online in 1982, and
then in the late 1980s and early 1990s the Ap Lei Chau site became the enormous 34-tower
South
Horizons development, in a joint venture with its immediate controlling
shareholder Hutchison Whampoa Ltd (HWL,
0013) and its controlling shareholder Cheung Kong
(Holdings) Ltd (CKH, 0001). HKE only got 20% of the upside
on South Horizons,
as the joint venture, Secan Ltd, was
20% owned by HKE, 50% by HWL and 30% by CKH and funded pro rata. Meanwhile CLP developed its old Hok Un power plant site into
Laguna
Verde, a 4m sq ft residential development in a 50:50 joint venture with CKH
in the late 1990s and early 2000s.